Asset Allocation | Monetary Policy & Inflation | US
The first rule of investing is to survive. That means not getting your investments wiped out. And that means sizing your positions so a big down-day will not significantly reduce the value of your overall investment portfolio. Therefore, recognising that crypto has much larger swings than equities suggests your crypto positions should be smaller than your equity exposure. But more important than sizing is to recognise when the market is in a fragile state with a much higher probability of large losses.
Markets Are in a Fragile State
That time is now. The Fed is gung-ho on raising interest rates to curb inflation even if it means slowing the economy. The market now expects almost 200bps of hikes for the rest of this year. If that holds, it will mean the Fed raises rates at every meeting, with two meetings seeing 50bp hikes. This would be a more aggressive hiking cycle than 2015-2019 and more like 2004-2006.
On top of this, the world is experiencing an energy price shock, which is often associated with global recessions. And that is before mentioning heightened geopolitical risks such as the Russia-Ukraine war.
Markets have taken note, with equities down 6% this year, crypto down 8-16%, and bonds down 5-10%. Only commodities are up this year – a whopping 39% (Chart 2). These asset classes have different volatilities, so we can adjust the returns by that. We find bonds have performed worst, followed by equities then crypto (Chart 3).
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Cash Is King
Therefore, for all the talk that, due to low yields, cash is a wasted investment and will not outperform inflation, it also will not lose you nominal value. It is better to be flat than to lose 5-18% on bonds, equities and crypto. This also suggests that in inflationary environments, cash, along with commodities, may end up being the best investment as cash limits your losses and allows you to survive.
What We Like
So, what are our investment preferences? We like to be:
- Underweight bonds and equities and overweight cash (Chart 1).
- We like to be modestly long crypto – as mentioned above, adjusted for volatility, it has underperformed less than equities. Plus, we think its flow dynamics are positive.
- Within US equities, we like to be overweight homebuilders, large cap value, reopening trades, semi-conductors and underweight financials, large cap growth and retail.
- Within European equities, we like to be overweight financials.
Very interesting article, thank you Bilal for this high level of clarity. Overweighting commodities and European financials is the play! Im convinced. Thanks